RRSP Vs TFSA: Which Is Right For You?

RRSP Vs TFSA: Which Is Right For You?




It’s never too early to start saving, but many Canadians are unsure about which saving and investment vehicles to use. Registered Retirement Savings Plans (RRSPs) are usually championed as the superior investment means and most Canadians are promoted to maximize their RRSPs first, with any excess funds going into a Tax Free Savings Account (TFSA). However, this is not always the best strategy for everyone. There are several groups whose maximized savings benefits are not best served by an RRSP.

Students and young workers:

Students and young workers with little income hardly have any room in their RRSPs, but TFSA has $5,000 a year whether or not they made any money. Students and young workers are also more likely to have debt. Paying off all debt, including house mortgage, is advantageous before investing in an RRSP. The unused RRSP contribution room carries forward to future years, so once you are debt-free and have more cash obtainable, you can take advantage of the built-up contribution room.

Older low-income workers:

In a low tax bracket, the tax deduction generated by an RRSP is less valuable than it is for high-tax bracket workers. Additionally, once they hit retirement, the poorest seniors can withdraw TFSAs tax free and wont harm income-tested programs. At age 65, Canadians start receiving OAS from the federal government. If you are a low-income senior living in Canada, you can also apply for the Guaranteed Income Supplement assistance. To qualify, your past year’s annual income (before income tested benefits) must not go beyond defined limits. Currently, the limit is $15,888 for a single person and $20,976 in combinded income for a associate. An RRSP, once converted into a RRIF or annuity, will generate income that will reduce or eliminate the GIS. Low income Canadians should probably direct any obtainable cash for retirement savings into a TFSA. Withdrawals from a TSFA will not cause clawbacks of income-tested government benefits and tax credit.

People with upcoming larger expenses:

There are hefty penalties on withdrawing from an RRSP early* (i.e. you are taxed at your current tax rate), consequently neutralizing most of the assistance of depositing into this account. There is no such penalty for a TFSA. These upcoming expenses may be reason enough to shy away from an RRSP – in many situations, putting this money towards a mortgage or debt can generate a better return-on-investment than an RRSP. For those whom a RRSP is not an ideal savings means, a better different may be a TFSA (Tax-Free-Savings-Account). The only real difference between an RRSP and a TFSA, however, is the timing of the tax. There is a large misconception that there is a larger tax-savings with the RRSP, due to the refund involved; however, the fact is that with the same rate of return and the same compounding period and continued tax rates at the date of contribution and withdrawal, the amount of after-tax cash that can be accumulated in an RRSP or TFSA is identical.

Take a simple example:

…………………………………………….TFSA……………………………….RRSP

Pre-tax Income…………………….$10,000……………………………$10,000

Tax (40%)…………………………….($4,000)………………………………n/a

Net Contribution……………………$6,000…………………………….$10,000

Growth at 5% / 20 years………..$20,318…………………………..$33,864

Tax Upon Withdrawal………………n/a……………………………….$13,546

Net Cash……………………………..$20,318……………………………$20,318

It is only when the tax rate upon withdrawal is lower or higher than your current rate that either the TFSA or RRSP is superior to the other. If you expect your tax rate to be lower than your current rate, then the RRSP wins out, but if your tax rate is higher upon withdrawal than it is currently, then the TFSA is a better savings means.

in spite of, if you can provide to, you should be maximizing both your RRSP and TFSA. According to RBC, three-fourths of Canadians will not unprotected to their retirement goals. In order to reach these goals, it is imperative that Canadians start maxing out both of these investment vehicles.

Additionally, TFSAs are ideal for investing; however, last year approximately 90% of TFSAs opened were savings accounts or GICs. Like an RRSP, these accounts can keep up stocks, bonds, mutual funds, ETFs and many more investment tools. You can shelter not only interest income, but also dividends and capital gains from tax.

So, during this tax-season, most Canadians should not only be thinking about depositing money into their RRSP, but should also be looking at depositing into their TFSAs and maximizing both of these savings accounts. However, if it is only possible to max out one of these savings accounts, do not assume that an RRSP is superior – both have advantages depending on your age, income, and saving needs.

For more information, contact Frontwater Capital.

*Please observe: tax penalties are excluded for the Home Buyers’ Plan which allows you to withdraw from your RRSP to build your home and for the Life Long Learning Plan which allows you to withdraw amounts to finance training or education for you or your spouse or shared-law partner.




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